Accounting & Finance for Bankers
Types of Bills & Discounting
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Types of Bills & Discounting
Introduction
Bills of exchange are one of the oldest and most important instruments in trade finance. For bankers, understanding the types of bills, the discounting process, and the accounting treatment is essential. This topic covers demand and usance bills, inland and foreign bills, bill discounting, rediscounting, and the regulatory framework.
What Is a Bill of Exchange?
As defined under Section 5 of the Negotiable Instruments Act, 1881:
"A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument."
Parties to a Bill
| Party | Role |
|---|---|
| Drawer | Person who draws (creates) the bill |
| Drawee | Person on whom the bill is drawn (who must pay) |
| Payee | Person who receives payment (may be drawer or third party) |
| Endorser | Person who transfers the bill by endorsement |
| Endorsee | Person to whom the bill is transferred |
Types of Bills
Based on Time of Payment
| Type | Feature |
|---|---|
| Demand Bill (Sight Bill) | Payable on demand/presentation — no credit period |
| Usance Bill (Time Bill) | Payable after a specified period (30/60/90 days) |
Based on Place
| Type | Feature |
|---|---|
| Inland Bill | Drawn and payable in India |
| Foreign Bill | Drawn in one country, payable in another |
Foreign bills are further classified:
- Export Bill: Drawn by Indian exporter on foreign buyer
- Import Bill: Drawn by foreign seller on Indian importer
Based on Documentation
| Type | Feature |
|---|---|
| Clean Bill | No documents attached — higher risk |
| Documentary Bill | Accompanied by documents of title (bill of lading, invoice, insurance) |
Documentary bills can be:
- D/P (Documents against Payment): Documents released only when drawee pays
- D/A (Documents against Acceptance): Documents released when drawee accepts the bill
Based on Purpose
| Type | Feature |
|---|---|
| Trade Bill | Arises from genuine sale/purchase of goods |
| Accommodation Bill | No underlying trade — drawn to raise finance |
| Supply Bill | Drawn on government departments for goods supplied |
Bill Discounting
Bill discounting is the process where a bank purchases or discounts a bill of exchange before its maturity date, paying the holder the face value minus a discount (interest for the unexpired period).
How Bill Discounting Works
- Seller draws a bill on the buyer for goods sold on credit
- Buyer accepts the bill (becomes the acceptor)
- Seller approaches their bank to discount the bill
- Bank pays the seller the face value minus discount charges
- On maturity, bank presents the bill to the drawee for payment
Discount Calculation
Discount = Face Value x Rate x Unexpired Period / 365
Worked Example
Bill amount: Rs 1,00,000; Period: 90 days; Discount rate: 12% p.a.
Discount = 1,00,000 x 12/100 x 90/365 = Rs 2,959
Amount paid to seller = 1,00,000 - 2,959 = Rs 97,041
Accounting Entries for Bill Discounting
At the time of discounting (Bank's books)
| Debit | Credit |
|---|---|
| Bills Purchased/Discounted A/c Rs 1,00,000 | Customer's A/c Rs 97,041 |
| Discount Earned A/c Rs 2,959 |
On maturity — if bill is honoured
| Debit | Credit |
|---|---|
| Drawee's Bank / Nostro A/c Rs 1,00,000 | Bills Purchased/Discounted A/c Rs 1,00,000 |
On maturity — if bill is dishonoured
| Debit | Credit |
|---|---|
| Drawer's A/c Rs 1,00,000 + noting charges | Bills Purchased/Discounted A/c Rs 1,00,000 |
| Noting Charges Receivable |
Rebate on Bills Discounted
- When a bill is discounted, the full discount is credited to income
- At year-end, the unexpired portion of the discount (relating to the next financial year) is treated as unearned income
- This is called Rebate on Bills Discounted
- It is shown on the liabilities side of the balance sheet
- NOT shown as accrued income on the asset side
Example
Bill discounted on 1 January for 90 days at 12%. Financial year ends 31 March.
- Total discount earned = for 90 days
- Earned this year = 90 days (Jan-Mar = 90 days, assuming March 31 end)
- If bill matures in April, only portion up to March 31 is earned; rest is rebate
Bill Rediscounting Scheme (BRDS)
- Banks that have already discounted trade bills can rediscount them with other institutions to raise funds
- Banks issue Derivative Usance Promissory Notes (DUPNs) in convenient lots and maturities
- Promotes bills culture in the economy
- Provides liquidity to the banking system
Tri-Party Repo
- Introduced to provide depth and liquidity in the corporate bond market
- Involves three parties: borrower, lender, and a tri-party agent
- The tri-party agent manages collateral on behalf of both parties
Eligibility of Tri-Party Agents
- Must have prior RBI authorisation
- Must be eligible under Payment and Settlement Systems Act
- Scheduled commercial banks, recognised stock exchanges, or clearing corporations
- Minimum paid-up capital: Rs 25 crores
- Minimum 5 years experience in financial sector
Advantages
- Reduces burden of collateral management
- Provides depth and liquidity in corporate bond market
RBI Guidelines on Bill Finance
| Guideline | Detail |
|---|---|
| Genuine trade bills | Banks must verify genuineness before discounting |
| Documents | Invoices, transport receipts, delivery challans required |
| Accommodation bills | Banks should be vigilant and avoid discounting |
| Tenor | Maximum usance period generally 90-180 days |
| Clean bills | Higher risk; banks may require additional security |
| Bill limit | Part of overall credit limit sanctioned to the borrower |
Bills in Banking Balance Sheet
| Item | Location |
|---|---|
| Bills Purchased/Discounted | Asset side under Advances |
| Rebate on Bills Discounted | Liability side (unearned income) |
| Bills Payable | Liability side under Other Liabilities |
| Bills for Collection | Contingent Liabilities (off-balance-sheet) |
Key Points to Remember
- Bill of exchange defined under Section 5 of NI Act, 1881
- Three parties: Drawer (creates), Drawee (pays), Payee (receives)
- Demand bill: Payable on presentation; Usance bill: Payable after a period
- D/P: Documents on payment; D/A: Documents on acceptance
- Trade bills have genuine trade backing; Accommodation bills do not
- Discount = Face Value x Rate x Days / 365
- Rebate on Bills Discounted = unearned income, shown on liabilities side
- Bill discounted and dishonoured → drawer's account is debited with face value + noting charges
- BRDS allows banks to rediscount trade bills via DUPNs
- Tri-party repo: three parties including agent; agent needs Rs 25 crore capital and 5 years' experience
- Bills Purchased/Discounted are classified as Advances in bank balance sheet
- Banks must verify genuineness of bills — check invoices, transport documents before discounting
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